Each weekend, I study market behavior using sentiment and technical indicators. The goal is to use clues, observation, and indicators to determine if we are in a bullish, bearish, or sideways market environment.
RELEASED: Understanding Options (McGraw-Hill, 2E), Understanding Stocks (McGraw-Hill, 2E), and Predict the Next Bull or Bear Market and Win (Adams Media): http://bit.ly/1bl0ZNk
My latest MarketWatch article: http://goo.gl/SJuzAW
AAII survey (7/2/2014)
38.5% Bullish. 22.4% Bearish. 39.1% Neutral.
Bearish: If sentiment is over 50% bullish.
Bullish: If sentiment is over 50% bearish.
Investors Intelligence (7/2/2014)
57.6% Bullish. 16.1% Bearish
Bearish: If sentiment is over 60% bullish.
Bullish: If sentiment is over 60% bearish.
VIX: 10.32 (on 7/5/2014)
Bearish: Less than or near 12.
Bullish: Greater than or near 40.
Moving Averages (daily): S&P 500 is above its 50-, 100-, and 200-day moving averages, and pointing up.
Bearish (Short-term Downtrend): Index crosses below 50-, 100-, or 200-day MA.
Bullish (Short-term Uptrend): Index crosses over 50-day, 100-day, and 200-day MA.
MACD (S&P 500): MACD is above zero line, and above its red 9-day signal line. (Note: I’m using the settings, 19,39,9, recommended by Gerald Appel, MACD’s creator.)
Bearish: MACD line crosses below 9-day (red or gray) signal line. MACD line (black line) crosses below zero line.
Bullish: MACD line crosses above 9-day signal line. MACD line crosses above zero line.
RSI (S&P 500): RSI is at 73.62 (on 7/5/2014)
Overbought (i.e. Bearish): When RSI rises to 70 or above.
Oversold (i.e. Bullish): When RSI falls to 30 or below.
Note: RSI can remain overbought or oversold for extended time periods.
Bonds: U.S. 10-year yield is at 2.65% (on 7/5/2014).
Note: 3.0% or higher is significant (consider selling bond funds as yield rises). 3.5% or higher and risk increases (for bondholders).
Analysis: Just like last week, sentiment indicators are frothy and overbought, which means the bulls think the market will not go down for a few years. Since human nature never changes, eventually the market comes back to earth, and sometimes very abruptly. Technical indicators are still showing the market is in an uptrend. When we look deeper, we see that as the market goes higher, fewer leading stocks are participating. This is a bearish signal. In addition, more Dow stocks are deteriorating, another red flag. To the inexperienced, the market appears strong. In reality, there are cracks.
Opinion: Now that the Dow just went past 17,000, it will be hard to convince most investors of the dangers that lie ahead. More long-time bears have thrown in the towel and given up on their bearish positions. Guess what? This is exactly what happens at market tops!
I know that it is hard to believe the market will ever go down. The cheerleading media, the Fed, Wall Street, and everyone connected to the financial markets are doing everything possible to make you believe the market goes in only one direction: up. They’re wrong. The market will go down, and it will happen sooner than most people think.
If you don’t believe me, try and remember January 2009. That was when the financial world seemed to be over and no one wanted to invest in the market. It was hard to convince anyone to buy at Dow 6,500. The stock market seemed like it would never go up again.
And now, five years later, we’re in a totally different environment. Like the game of Three-Card Monte, while the market reaches all-time highs, leading stocks are selling off, stocks making new highs are shrinking, and the market internals are deteriorating. I know that it is nearly impossible to convince anyone that the bull market might end, but it will, and sooner rather than later. It’s true the Fed has helped the market higher with QE and other financial tools, but that will end.
If you want to play it safe, stay in cash and wait. Do not pay attention to the clowns wearing party hats. They will be the most shocked and amazed when the market turns against them, as it always does. That’s when they say, “Who could have known?” And after the market cracks for the first time, many ultra bullish investors will pretend they were always bearish. Human nature never changes.
Because the market is still going up and might for a little while longer, it’s safer to wait for a bearish pivot or inflection point. At some point in the near future, the market will crack, even if a little. When that happens, I will let you know. Right now, only the most aggressive traders are shorting, and they are feeling some pain (I also have a few short positions but am very comfortable holding them). But the most prudent strategy is to wait on the sidelines and be ready to pounce.
This bull market is nearing an end, and I admit it’s taking longer than I anticipated. Still, the S&P is up 7.42 percent year to date. As I’ve said many times before, be patient and prudent. In my opinion, the downside risk is much greater than what you can potentially make on the upside. Making $0 in cash isn’t ideal, but it’s a lot better than losing money.
Bottom line: Be prepared for some market fireworks in the near future.
* Note: These signals are not actionable trades, but only guidelines. Always use other indicators, and your own research, to confirm before buying or selling.